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May 3, 2014

Today’s Bond Market Slams Conventional Wisdom

For Treasury doomsayers, the great collapse of unmanageable public debt will have to wait

Fed Chairwoman Janet Yellen testifying before the House. (Photo: AP)

Late last year, just before the Federal Reserve began its scaling back on monthly Treasury bond purchases, the conventional wisdom was that interest rates would rise and bond prices would fall. Invariably, the consensus opinion was — at it has been since quantitative easing began in 2008 — “interest rates have nowhere to go but up.”

In this case, the widespread belief was a simple measure of supply and demand. Logically, if the Fed is buying fewer Treasuries, it would create less demand for U.S. debt and cause bond prices to trade at lower prices.

Yet, like so many times before, the logic of conventional wisdom was dead wrong. And this time is no different.

In January, the Fed reduced its monthly QE-bond purchases to $65 billion per month. Instead of crashing like many people expected, ETFs tied to the performance of long-term Treasury bonds like the iShares 20+ Year Treasury Bond ETF (TLT) suddenly jumped almost 6% in January. The SDPR S&P 500 ETF (SPY), by comparison, fell 2.59%. Who could’ve foreseen such a berserk outcome?

During its just completed FOMC meeting, U.S. policy makers agreed to cut QE even further – to $45 billion. How did the bond market react? Prices moved higher while yields marched lower. The sheer madness of what shouldn’t be happening keeps happening!

Now with 2014 almost half way over, the yield on 10-year and 30-year U.S. Treasuries has done the exact opposite of what most analysts predicted; by sliding in the vicinity of 12-13%.

Meanwhile, traders in Treasury bond ETFs that go long with leverage have been printing money. The ProShares Ultra 20+ Yr Treasury ETF (UBT) and Direxion Daily 20+ Treasury Bull 3x Shares (TMF) are sitting on YTD gains between 21% to 33%. Not a bad year for four months of work. UBT uses 200% daily leverage while TMF uses 300%.

The only places within the U.S. equity market where stocks have been keeping up with the sizzling performance in long-term Treasuries have been with utilities (XLU) and REITs (VNQ). Both sectors have been the beneficiaries of tame interest rates, which attract dividend investors looking for more yield.

For Treasury doomsayers, the great collapse of unmanageable public debt will have to wait. Market prices are the boss, and right now the bond market isn’t done dismantling all of the logical conclusions and conventional wisdom about what comes next.

“As investors, we also always have to be aware of our innate and very human tendency to be fighting the last war. We forget that Mr. Market is an ingenious sadist, and that he delights in torturing us in different ways,” said Barton Biggs.

Indeed, the bond market is torturing plenty of investors (and their advisors), and hopefully you’re not one of them.